RISING TRADE DEFICIT INCREASING INFLATION AND PLACING PRESSURE ON RESERVES

SAAD ANWAR HASHMI
(feedback@pgeconomist.com)

Aug 13 - 19, 20
12

Pakistan is facing a tough challenge with the widening of the trade imbalance where imports double that of exports putting constant pressure on the current account. According to Pakistan Bureau of Statistics, imports were USD 44.912 Billion in FY12 as compared to USD 40.414 billion in FY11, an increase of 11.13 percent. On the contrary, exports reduced from USD 24.81 billion in FY11 to USD 23.64 billion in FY12, a decline of 4.71 percent increasing balance of trade from USD 15.60 billion in FY11 to USD 21.27 billion in FY12, an increase of 36.32 percent. SBP reserves as on August 2012 are USD 14.57 billion. Pakistan being a net importer has put further pressure on reserves for import payments with the devaluation. It is expected that with the current state of the economy, slow inflow of foreign investments and impending debt payment against the IMF loan will put pressure on reserves with reduction to approximately USD 10 billion by December 2012. The SBP is left with little option but to utilize the foreign reserves if no external source is available in the short run. As per expectations, the trade deficit is expected to remain between USD 16 billion to USD 20 billion through FY13. The devaluation of the exchange rate has further put pressure on reserves through settlement of import payments. Pakistan received USD 1.1 billion on August 2nd, 2012 against the Coalition Support Fund which gave some comfort to the dwindling reserves.

Burden on the reserves is brought about only because the country is not making significant efforts to bridge the gap between imports and exports. With import bills rising due to the constant devaluation of the Rupee against the Dollar, the country is facing inflationary pressures therefore increasing the balance of trade. Since increase in costs are not absorbed and transferred to the final consumers, high inflation is pushing the population below the poverty line causing numerous economic problems including lawlessness and an increase in crime. There have been frequent revolts against inflation which increases the cost of living, particular cost of food which is a prime sustenance for those earning a minimum wage. Inflation which persists in the economy is driven through demand and supply side pressures, however it is difficult to ascertain the degree to which either supply or demand or both have contributed to constant increases in inflation witnessed in the economy. SBP carries out strict measures to control the money supply in the economy to reduce inflation, however there seems to be major misalignment between both monetary and fiscal measures to reduce inflation.

The Inflation rate in Pakistan is expected to remain in double digits through FY13 through Pakistan Bureau of Statistics estimates that CPI may reduce to single digits between 9.5 percent to in FY13. It must be highlighted that inflation has been in double digits since year 2003. Based on the latest Inflation Monitor report by SBP issued in July 2012, inflation is on a rise among all income levels and across most commodities and products used for daily consumption. Major increases have been witnessed among wheat, pulses, eggs, milk, sugar, fruits and vegetables which will continue to be volatile. CPI is recorded at 12.4% as on July 2012, one of the highest in the region. The reasons for inflation in Pakistan are numerous some driven through supply while others driven through demand side pressures.

With the constant rise in the price of fuel due to international oil prices, such increases not only increase the cost of production but also cost of transportation which affects the price of commodities across the board. Based on the understanding of those involved in day to day street business, any increase or decrease in the price of fuel does not translate into an equivalent percentage increase or decrease in the price of commodities which means that the price will be volatile considering the cost of inputs. There is no authority which effectively monitors exponential or justifiable increase or reduction in the price of commodities, therefore no effective price control mechanism exists which continues to be a cause of concern.

One such respite for the reserves are worker remittances averaging more than USD 1.0Bn per month. Pakistan recorded an inflow in worker remittances of USD 13.186 billion in FY12 compared to USD 11.20 billion in FY11, growth if 17.7%. Worker remittances have been increased through the Remittance Initiative (PRI) initiated by the Government in 2009. Though seen as a positive sign to build reserves, further increases in such inflows are also being viewed to cause an increase in money supply which causes inflation. The impact of such flows is minimum as SBP can very well easily mop up the excess money supply in the economy with an attempt to manage inflation.

Though there is pressure on the rupee through devaluation, GDP is expected to grow and remain between 2.8% and 3.2% through FY13. With respect to inflation driven through the demand side, Pakistan with a population of 180 million people is a natural component for inflation with a need to constantly increase food supplies for the masses. The measures to control inflation and build reserves may only be possible if stringent measures are undertaken to control the budgetary and trade deficits through an increase in exports and tax base of the economy, both through direct and indirect taxation which in turn will reduce the need for government borrowing. If the trade deficit keeps increasing, SBP will witnesses a reduction in dollar reserves which may further result in the devaluation of the currency thus keeping the spiral of inflation uncontrollable. Building a healthy export base and encouragement of international investments in Pakistan through creating and enabling environment is paramount to build reserves. The country needs to keep the Rupee Dollar parity stable and avoid further devaluation in the currency since exports cannot be increased unless macro issues faced by the economy are addressed.